THE IMPACT OF THE RAND ON THE VALUE OF
THE JOHANNESBURG STOCK EXCHANGE
G.D.I. Barr and B.S. Kantor1
Abstract
The relationship between the foreign exchange value of the rand and the Johannesburg Stock
Exchange (JSE) was put to a particularly interesting test over the period 2000 to 2003 when the
rand first collapsed and then recovered. In this paper, we look at the effects of the nominal and
real exchange rate changes on the nominal and real value of the overall JSE market and then in
more detail at particular counters that exhibit common characteristics with respect to the rand
exchange rate. These we define as either: rand hedge stocks, that is, those companies with mostly
US dollar revenues and US dollar costs; rand leverage stocks, that is, those companies with
predominantly US dollar revenues and rand costs; or randplays, that is, those companies that earn
almost all of their profits by generating rand revenues and incurring rand costs. We report on the
impact of the rand on the value of the largest 40 stocks on the JSE and classify these stocks
according to the criteria mentioned above. In addition, we explain how rand plays can be
expected to lose rand value as the rand weakens, despite higher inflation and an increase in the
rand value of the JSE All Share index. We also note that, counter-intuitively, the foreign currency
value of Richemont, a pure rand hedge company, can be influenced by the foreign exchange
value of the rand, a phenomenon we attribute to an investor constituency that includes a large
SA component.
Introduction
The period between 2000 and 2003 has been one of extreme movements in the nominal and real
value of the rand and we trace the nominal and real effects of these exchange rate changes on the
JSE over this period. In this paper we examine the relationship between the value of the JSE as
represented by its All Share index and its Top 40 companies and the exchange value of the rand.
In addition, we examine the impact of the rand exchange rate on the foreign currency value of
two JSE listed companies: Harmony, a gold mine, and Richemont, with its interests in the
manufacturing and distribution of luxury goods (as well as tobacco, through a large holding in
British-American Tobacco) as well as the responses of the JSE Banks index to changes in the
value of the rand. 2
1
University of Cape Town and Investec Securities, [email protected] [email protected].
An earlier version of this paper was presented to the Conference of the Economic Society of
South Africa, September 2003.
2
In the study, we use monthly data from Bloomberg Financial Markets, I-Net Bridge, and the
South African Reserve Bank.
1
1.
The History Of Exchange Rate Changes In South Africa
In Figure 1, we demonstrate and compare the behaviour of the trade-weighted real rand, the
nominal trade weighted rand, and the real rand-dollar exchange rate over the period 1980-2003.3
In August 1985, it is seen that the rand was subject to a severe real and nominal shock when the
government of the time failed to cross the “Rubicon” to democratic rule in South Africa and
severely disappointed financial markets. As a result foreign capital was withdrawn on a very large
scale, putting immense pressure on the exchange rate. An exchange rate shock of equivalent
magnitude to that experienced in 1985 occurred in November and December of 2001 when the
rand fell sharply but in this case the explanation for the shock was much less obvious and has
largely defeated official attempts to explain it.4
We also show the volatility of the nominal and the real rand in the period 1998-2003 when the
nominal rand collapsed and then recovered, taking the real rand with it (Figure 2). Since rates of
inflation have generally been below 10% in South Africa since 1996, and inflation with our
trading partners has generally been lower than 5%, the difference in inflation rates between SA
and its trading partners has been quite small in magnitude since the mid-1990s. Purchasing
power parity (PPP) would, of course, dictate that the expected depreciation of the rand was equal
to the difference in expected inflation rates. However, if one decomposes nominal exchange rate
movements into a difference in inflation component plus a real shock component, it becomes
clear that most of the movement in the nominal exchange rate would be classified as real shock
movements and, by definition, constitute unexpected movements in the exchange rate. This is
indicated in Figure 3 where the real shock component is calculated as the percentage change in
the nominal trade-weighted exchange rate minus the difference between percentage changes in
local prices and a trade-weighted percentage change in foreign prices. When the shock
component dominates, the real and nominal exchange rates will exhibit a similar pattern of
movement as in evident in Figure 2. 5
3
The trade-weighted rand is calculated by the South African Reserve Bank; see, for instance,
Quarterly Bulletin (June 2003), S105. The formula for the real exchange rate is: real R/$ =
(1/ZARt) *(SACPIt/USCPIt), where ZARt is the nominal or market exchange rate, and SACPIt
and USCPIt represent the South African and U.S. consumer price indices with a common base
(e.g. January 1995=100).
4
See the Myburgh Commission of Enquiry into the collapse of the rand in 2001. (The
commission‟s report is available at http://www.polity.org.za/html/govdocs/reports/). We have
ascribed the rand‟s collapse to a panic demand for foreign exchange from wealthy individuals
with newly found access to hard-currency assets made available through the asset swap
mechanism. Effectively the only limits imposed on these demands for US dollars were the rands
individuals could muster for the purpose. We describe this panic demand for US dollars as one
of the unintended effects of partial exchange control reform (see Kantor and Marchetti (2003),.
5
For an explanation of the real rand exchange rate see ( MacDonald and Ricci 2003 ) For an
overview of alternative exchange rate regimes for emerging markets see (Calvo and Mishkin
2003) also (Ho and McCauley 2003)
2
Real & Nominal Rand Exchange Rates
1980.01 - 2003.04
500
400
300
200
100
0
80
82
84
86
Real (Trade-Weighted)
88
90
92
94
96
Real (US$)
98
00
02
Nominal Trade Weighted
Figure 1.
Source: South African Reserve Bank
Real & Nominal Rand Exchange Rates
1998.01 - 2003.04
120
100
80
60
40
20
1998
1999
Real (Trade Weighted)
2000
2001
Real (US$)
2002
2003
Nominal Trade Weighted
Figure 2.
Source: South African Reserve Bank
3
%real
%price
Jan-03
Jul-02
Jan-02
Jul-01
Jan-01
Jul-00
Jan-00
Jul-99
Jan-99
Jul-98
Jan-98
Jul-97
Jan-97
Jul-96
40.0%
30.0%
20.0%
10.0%
0.0%
-10.0%
-20.0%
-30.0%
-40.0%
-50.0%
Jan-96
Trade Weighted Rand exchange rate - 1996.01 - 2003.06
Components of movements - real (shocks) moves and price differences
Figure 3.
Source: South African Reserve Bank
2.
Causes and Effects of Exchange Rate Changes
It is worth noting that when exchange rates simply follow differences in price trends, that is
when PPP holds, there will be no real exchange rate effects on firms engaging in foreign trade
since any gain or loss incurred by traders on the exchange rate leg will be lost or gained through
differential prices charged in the home or foreign market. Of course, a market determined
exchange rate may well deviate significantly from its PPP, and so affect real profits earned
through international trade. We will identify these real effects on the operating profits of firms
made by real exchange rate changes in some detail below. Movements of exchange rates away
from PPP, and the effect such movements have on international competitiveness may, in turn,
have effects on prices or exchange rates that tend to bring the exchange rate back to its PPP
value. For example, a shock to the capital account of the balance of payments that causes a
sudden depreciation of the real exchange rate will be followed by higher prices for goods and
services including labour services. These higher prices will increase the value of the real exchange
rate and move the nominal exchange rate back towards its PPP equivalent. Any recovery in the
nominal exchange rate from its post-shock level that may accompany the higher domestic prices
will have ac ommensurate effect on the real exchange rate. Provided the nominal exchange rate,
subsequent to the shock, depreciates by less than the post-shock differences in inflation, the real
exchange will recover the ground it has lost. Similarly, any increase in the supply of foreign
capital that shocks an exchange rate to move above its PPP level will be accompanied by
downward pressure on prices, with the resulting lower inflation rate mitigating against any rise in
the real exchange rate.
Exchange rates movements have causes. Usually the root of these causes are monetary, and
influence prices more generally rather than specifically on the price of a unit of foreign exchange.
If the causes of movements in the nominal exchange rate are the purely monetary ones
responsible for excess domestic demand, then exchange rates will approximate PPP fairly closely.
It is, however, the non-monetary forces on the supply and demand for foreign exchange such as
capital account shocks or productivity shocks, following, for example, the discovery and
exploitation of valuable mineral deposits, that can cause the exchange rate to deviate from PPP.
Exchange rate movements after such a shock will then have an effect on prices that will move
exchange rates towards PPP. After an exchange rate shock, competitive forces will tend, with a
lag, to directly increase or decrease the domestic prices of imports and exports whereas the
prices of goods and services that are less directly involved in foreign trade will also in turn be
affected by competition from the tradable goods sectors. Of course, further events and exchange
4
rate shocks may interrupt any smooth progress back to a PPP equilibrium, but the impact of an
exchange rate shock on prices and profits will often be quite clear and predictable.
3.
The Rand Exchange Rate and the JSE
We now turn to the exchange rate effects on the value of the JSE. We begin with a description of
the value of the JSE since 1980. The relationship between the level of the JSE expressed in
current prices and the foreign exchange value of the rand is obviously a close one since both are
simultaneously affected by SA inflation. In fact, the JSE has tracked the R/US$ exchange rate
quite closely over the entire period implying a fairly long-run constant value of the JSE measured
in US dollars over the 23 year period examined. At year end 2002 the JSE was about 20% higher
in dollars than in the early eighties. Since the real exchange rate in dollars has declined about
20% over the same period this means that the JSE has barely kept up with inflation over the
period examined. In comparison, the US market has shown spectacular real growth over the
same long run period.
Figure 4.
14
12000
12
10000
10
8000
8
6000
6
JSE Index
R/$ (in Fin. Rand where applicable)
R and/$ ex c hange rate & the J SE All- s hare Index
1980.01 - 2003.04
4000
4
2000
2
0
0
80 82 84 86 88 90 92 94 96 98 00 02
R /$ (in FR w here applic able)
J SE All-Share
Source: South African Reserve Bank
Since 2001, when the rand first weakened dramatically and then recovered, the rand value of the
JSE All Share index has responded very directly to changes in the exchange rate rising with rand
weakness and falling with rand strength (see Figure 4). However, not all sectors of the JSE
responded in this general way and individual companies were clearly affected in line with the
market‟s perceptions on how these real exchange rate changes would impact on company
operating profits and dividend flows. We now examine in detail how the individual operating
characteristics of listed companies would determine the way in which their profitability, and
hence their share price, would be affected by exchange rate changes.
5
3(a)
Share Prices And Leverage On The JSE: A Formal Treatment
Share prices on the JSE clearly reflect the market‟s best attempt to find the present value of the
expected benefits from owning a share of the company. These benefits will be derived from
expected future earnings and dividends or from the sale or liquidation of the company.
These earnings and dividend flows from JSE listed companies may be generated from:
a)
b)
c)
company operations that are almost completely SA-based. We define these companies
listed on the JSE as rand plays, e.g. retailers (such as Pick „n Pay) or banks (such as Absa)
with almost all their revenues generated and costs incurred in South Africa in rands;
companies listed on the JSE that are almost completely foreign based, generating only
foreign „hard‟ currency income and incurring only foreign costs and known as rand hedge
stocks, e.g. Liberty International, a UK property owner and developer, or Richemont;
companies that are SA-based and incur costs in SA but sell their products in hard
currency, e.g. resource stocks such as Harmony, which we describe as rand leverage stocks.
We consider the dividend at time t (expressed in rands) and denoted Divt for each of the cases
above:
a)
Rand play: Divt is proportional to profit at time t,
( R) Re vt  ( R)Costt
b)
Rand hedge: Divt is proportional to profit at time t denominated in, say, US dollars and
then converted into rand to give,
R / $t *  $ Re vt  $Costt 
hence the profits of a rand hedge company in dollars will be directly impacted upon by the
rand/US$ exchange rate; a weaker exchange rate will increase the dividend flow in rands for any
given profit in dollars.
c)
Rand leverage: in the third group (typically resource companies), the rand price of their
shares reacts to the dollar prices of their traded resources as well as to the rand/US$ exchange
rate. A weaker rand increases the rand price of commodities and lowers the dollar-denominated
costs of inputs, mainly labour. This effect would, primarily, be a short-term effect. Prices and
particularly labour costs would be expected to rise as a PPP equilibrium was re-established and
the real rand depreciation eliminated. Thus, a weaker rand would result in an increase in dollar
earnings for as long as dollar costs were below their PPP value; as PPP is re-established, dollar
prices of labour would rise.
In this case, as in (b) above, Divt is proportional to dollar profit at time t denominated in dollars
and then converted into rands. Although revenues are earned in dollars, costs are denominated
in rands to give dollar profit at time t:


R / $t *  $ Re vt  ( R)Costt *  1

R
/
$
t



6
However, rand costs rise in line with the consumer price index. Thus, dollar costs will be linked
to the relative movement of the CPI and the exchange rate. At time t+n, dollar profit will be:



CPIt  n

* 1
R / $t  n *  $ Re vt  n  ( R)Costt * 


CPI
R
/
$
t n 
t 


Thus, assuming dollar revenues are fairly stable, dollar profits n periods in the future are
determined by the relative movement of the CPI to the rand/US$ exchange rate over the n
periods. For example, rand depreciation will lower dollar costs and create a leveraged effect on
dollar profits. But, as CPI catches up over time with any depreciation in the rand (or vice versa)
and PPP is re-established, the leverage effect dissipates and the short-term improvement in
dollar profits due to the real rand depreciation disappears. In other words, leverage effects
measured in dollars which stem from an exchange rate depreciation are merely short-term effects
and do not fundamentally affect long term value.
In rand terms, prices should reflect these leveraged dollar effects values but, assuming PPP will
hold, the long term value should primarily be determined by expectations of dollar-denominated
resource prices and expectations of rand/US$ exchange rates.
In order to test the sensitivity of the major companies listed on JSE to changes in the value of
the rand over the period of rand turbulence of 2001 to 2003, we tested the following models.
(All data are in weekly form.)
% ALSI i    1 %R /$  2 % ALSI 40
where:
% ALSI i is the continuously compounded percentage change of the i-th component
of the ALSI40;
%R /$ is the continuously compounded percentage change of the rand/US$
exchange rate;
%ALSI 40 is the continuously compounded percentage change of the ALSI40.
The model attempts to capture a market-wide effect through the ALSI40 variable and an
exchange rate-specific effect. Although the overall movement of the market as reflected by the
ALSI40 will be related to the exchange rate, when expressed in percentage change form the
correlation is a low 0.23 reflecting a tolerable degree of multicollinearity.
The betas are calculated for this model over the period from January 2001 to August 2003, and
listed in the table below. The larger the estimated exchange rate beta, the greater the degree of
responsiveness of the share price returns to changes in the value of the rand (in the same
direction if the beta is positive, and in the opposite direction if beta is negative). In the table
below, we rank the estimated betas for shares in each of the three a priori group classifications
(rand leverage stocks, rand hedges and rand plays). These betas give an empirical estimate of the
degree of rand sensitivity the companies exhibited over the period January 2001 to August 2003.
It is seen that the degree of fit for each ALSI40 component model and the significance of the
estimated coefficients vary substantially across the different ALSI40 components, reflecting for
each share the amount of company-specific variation vis-à-vis exchange rate and market variation
over the period. However, the exercise is primarily intended as a broad means of classifying the
shares into groups rather than a close analysis of the reliability of the individual coefficients. As
such, it is seen immediately that the empirical estimates for reflect the a priori categorisation
7
closely and thus the calculated beta coefficients for the exchange rate variable ( ̂1 ) serve as
strong empirical support for categorising the status of the ALSI 40 as either rand leverage stocks,
rand hedges or rand plays.
According to our classification, it may be seen that those companies classified as rand leverage
companies had positive estimated rand/US$ betas (with the exception of Gold Fields). These
rand leverage companies are all resource producers with US$ based revenues (with the exception
is Steinhoff, a large vertically-integrated furniture manufacturer with plants in South Africa and
elsewhere and with a large proportion of its sales made outside South Africa). Those companies
in the rand plays category, by contrast, turned out to all have negative R/$ betas. This means that
such shares have tended, as expected, to appreciate with rand strength against the dollar and
depreciate with rand weakness and are generally companies with a very large proportion of their
revenues and operating profits generated in South Africa. Some locally based companies, which
we have classified as rand plays, such as Barloworld and the large banks, still have significant
proportions of their assets invested offshore but, despite this, their rand values do not seem to
have benefited much from rand weakness. Old Mutual, with a very large proportion of its assets
held offshore is generally considered as a rand hedge and we have classified it along with SAB
Miller, Richemont, and Liberty International in the rand hedge group but has exhibited a
negative estimated R/$ beta. 6 While Richemont and Liberty International are pure rand hedges
with all their revenues and costs incurred outside of South Africa, both Old Mutual and SAB
Miller still manage a significant proportion of SA-domiciled assets and earn a disproportionate
share of their profits from local operations. Significantly, unlike Old Mutual, SAB Miller has a
positive R/$ beta and clearly offers protection against rand weakness. It is thus seen that
although several companies do not neatly fit into one of the three categorisations we consider
because of their mix of local and foreign assets, the categorisation remains a very useful one with
strong empirical support.
6
All the companies classified as rand hedges are listed on the JSE but have their primary listing
on other exchanges and are legally domiciled in the United Kingdom or Switzerland while two of
the rand leverage companies, Anglo American and BHP Billiton, have dual listings
(Johannesburg and London stock exchanges) and are foreign-registered companies.
8
Table 1. Beta Estimates for Rand Hedge, Rand Leverage and Rand Plays
JSE
Code
̂1 (R/$ Beta)
t ( ˆ1 )
̂ 2 (AlSI 40 Beta)
t ( ˆ2 )
LBT
SAB
RCH
OML
0.64
0.45
0.27
-0.22
6.46
3.80
1.78
-1.61
0.34
0.53
1.07
1.00
4.85
6.49
9.89
10.47
0.42
0.38
0.49
0.46
ISC
IMP
SOL
BIL
HAR
SHF
AMS
AGL
SAP
ANG
KMB*
AVG
REM
GFI
0.64
0.49
0.43
0.32
0.24
0.22
0.17
0.12
0.06
0.05
0.03
0.02
0.00
-0.04
2.30
2.56
2.48
2.69
0.75
1.41
0.88
1.07
0.35
0.20
0.12
0.09
0.04
-0.14
0.94
1.16
0.61
1.19
0.77
0.57
1.21
1.54
1.16
0.68
1.30
0.57
0.40
0.77
4.79
8.59
4.98
14.12
3.42
5.23
9.01
19.80
10.19
4.14
5.30
3.83
5.14
3.85
0.23
0.45
0.25
0.66
0.11
0.23
0.43
0.78
0.47
0.13
0.31
0.11
0.18
0.11
-1.74
0.72
1.13
0.70
0.57
0.76
0.82
0.65
0.54
0.40
0.67
0.65
0.49
0.83
0.51
0.86
0.54
0.80
0.31
1.73
7.87
6.38
7.26
6.09
7.30
5.65
6.99
5.22
3.83
7.09
5.26
5.58
8.88
4.43
0.46
5.50
6.21
3.51
0.15
0.34
0.24
0.30
0.25
0.29
0.20
0.28
0.18
0.13
0.28
0.18
0.20
0.37
0.13
0.01
0.19
0.23
0.09
0.46
-1.71
0.61
4.28
3.75
7.90
0.12
0.10
0.33
R2
RAND HEDGE
Liberty International
SABMiller
Richemont
Old Mutual
RAND LEVERAGE
Iscor
Impala
Sasol
BHP Billiton
Harmony
Steinhoff
Anglo Platinum
Anglo American
Sappi
Anglo Gold
Kumba
Avgold
Remgro
Gold Fields
RAND PLAY
Telkom
TKG*
-0.78
0.64
Firstrand
FSR
-0.67
-5.19
Naspers
NPN
-0.65
-2.58
RMB
RMH
-0.63
-4.63
Imperial
IPL
-0.60
-4.50
Sanlam
SLM
-0.55
-3.71
MTN
MTN
-0.55
-2.66
Standard Bank
SBK
-0.53
-4.01
Nedcor
NED
-0.50
-3.38
Pick 'n Pay
PIK
-0.50
-3.34
Liberty Group
LGL
-0.45
-3.30
Absa
ASA
-0.44
-2.48
Bidvest
BVT
-0.42
-3.38
Barloworld
BAW
-0.40
-2.98
Woolworths
WHL
-0.40
-2.42
Investec Plc
INP*
-0.35
-0.15
Nampak
NPK
-0.32
-2.30
Investec Ltd
INL
-0.26
-1.39
Amalgamated
ABI
-0.25
-1.97
Beverages
Network Healthcare
NTC
-0.21
-1.37
Tiger Brands
TBS
-0.20
0.31
Venfin
VNF
-0.14
-1.25
* Kumba (7 December 2001 to 8 August 2003), Investec plc (2
and Telkom (14 March 2003 to 8 August 2003).
August 2002 to 8 August 2003)
9
3(b)
Finding the Best Hedging Strategy ?
We now turn our attention to the problem of determining which of the two (rand leverage or
rand hedge) is expected to provide the best protection against rand weakness. Based on the
results generated by these models, for JSE-based investors, leverage stocks offer more effective
protection against rand weakness than rand hedge stocks. As mentioned above, any relative
disadvantage to pure rand hedge stocks in comparison to rand leverage stocks would be expected
to be a short-term effect only, as foreign currency input costs are forced down below their PPP
equilibrium level in the short-term. In the longer-term, both classes of stock are simply affected
by the dollar price of what they sell (rand leverage stocks) or on the profitability of their overseas
operations (rand hedge stocks).
We examine two large market capitalisation stocks: Harmony (a rand leverage stock) and
Richemont (a rand hedge stock), and demonstrate empirically that short-term changes in the real
value of the rand are transmitted to prices of these stocks. We also show that these stocks, when
denominated in foreign currencies (US dollar and Swiss franc), vary in ways not suggested by
standard theoretical analysis. Specifically, the foreign currency-denominated value of rand hedge
shares is independent of the rand/US$ exchange rate itself. We show that, with market- and
sector-wide effects removed, the short-run link between Richemont and the rand is significantly
positive, whereas for Harmony it is significantly negative. In the case of Harmony, we will
demonstrate a curious but previously documented feature (Barr(1982)): there is an exchange rate
effect on the US dollar value of Harmony, but one operating with a lag of about nine months.
This indicates that the gold market and the exchange rate market are operating somewhat
differently from the gold share market in determining value.
Figure 5.
Share price (in Rands)
R/$ = 8.0
120.
R/$ = 7.52 (September 16, 2003)
Harmony
R 111.1 (Sept. 16th, 2003)
C
100.
B
A is price in market
at current exchange rates
B is price in market reflecting
a lower exchange rate of say R/$ = 8.0,
with no leverage effects assumed
800.
A
C is price in market reflecting
a leverage type effect either because:
1. market expectation of exchange
rate weakening
2. SA Exchange control effect (RCH)
400.
O
P
P'
Share price (in $)
The essence of our observations is captured in Figure 5, which presents a snap-shot of the
Harmony share prices‟ exchange rate responsiveness as at 16 September 2003. If the share is
10
valued at P in US dollars in the short-term, and the rand/US$ exchange rate is expected to
weaken from, say, R7.43 to R8.00 per US dollar, you would expect the US$ value of Harmony to
weaken along the line P from A to B. In the case of Richemont it has tended to move to C,
reflecting a type of leverage effect. In the case of Harmony, the share may move beyond C and
tends to be linked to averages of gold prices and exchange rates over the previous year.
Case Study 1: Richemont, An Unleveraged Pure Rand Hedge
Richemont grew out of South Africa‟s Rembrandt Group and, as such, is a dual-listed stock
quoted on the Johannesburg and Zurich bourses. It is the largest (non-resource) stock on the
JSE. As a pure rand hedge, one would not expect the foreign currency (Swiss franc or CHF)
value of Richemont to be linked to the ZAR/CHF exchange rate when the sector and market
specific components are stripped out of the share. We remove these effects by considering the
ratio of Richemont to Louis Vuitton Moët-Hennessy (LVMH), the world‟s largest luxury goods
group, over the period January 2000 to June 2003.
Figure 6.
Richemont and LVMH (Swiss Francs)
3000
100
2500
80
2000
1500
60
1000
40
500
0
20
95
96
97
98
99
RCH
00
01
02
03
LVMH
If we remove the market and sector effects, that is, consider the ratio of Richemont to LVMH
and relate it to percentage changes in the ZAR/CHF exchange rate we get the following:
11
Figure 7.
Relative Strength of RCH related to R/SWF
2.0
80
1.8
70
1.6
60
1.4
50
1.2
40
1.0
30
0.8
20
95
96
97
98
99
00
Ratio RCH t o LVMH
01
02
03
R/SW F
It can be seen that when the Rand weakened sharply during the emerging market crisis in
September 1998, and again in the latter half of 2001, Richemont has strengthened relative to its
peer LVMH. This pattern is made particularly clear in a cross-section plot of the ratio of
Richemont to LVMH and the year-on-year percentage change in the ZAR/CHF exchange rate.
12
Figure 8.
Ratio RCH to LVMH to % R/SWF
1996.01 2003.06
60
ZARCHF % yr-on-yr
40
20
0
-20
-40
0.8
1.0
1.2
1.4
1.6
1.8
2.0
Ratio RCH to LVMH
These two variables are clearly positively correlated (r = .604 between January 1996 and June
2003, rising to r = .706 over the period January 2000 to June 2003). This contradicts our a priori
reasoning, namely, that the CHF price of Richemont (a pure hedge stock) would not be related
to the ZAR/CHF exchange rate. The consistent explanation is that, so long as exchange control
remains in South Africa, Richemont will serve that cohort of investors seeking a foreign currency
hedge. As this cohort of South Africans is an important component of shareholders in the case
of Richemont, they will tend to push the price up in times of exchange rate volatility, particularly
when there has been sharp exchange rate depreciation and fear of further exchange rate
weakness rise.
In Figure 5, therefore, rather than move up and down line P as the exchange rate changes,
investors push the price up to C. This may be understood as imputing an exchange rate to the
share than is weaker than the ruling market exchange rate at the time.
Case Study 2 – Harmony, A Leveraged Rand Hedge Stock
As mentioned previously Harmony is classified as a leveraged rand hedge stock, in the sense that
its costs are rand-denominated and its income stream is foreign currency-denominated. Certainly,
in the short term, a weaker rand is associated with falling dollar input costs and hence, for any
given dollar gold price, higher dollar profits. Depending therefore on investors‟ time horizon,
weakness in the rand/US$ exchange rate will have a positive effect on Harmony‟s dollar value,
but this effect will weaken as PPP re-establishes itself.
13
As with Richemont, we consider the prices of Harmony relative to Newmont, a US gold mining
company, which we use to remove market- and sector-wide effects from the share price.
Figure 9.
HAR and NMT in US$
2000
70
60
1600
50
1200
40
800
30
400
20
0
10
95
96
97
98
99
HAR in $
00
01
02
03
NMT in $
Figure 10.
Relative Strength of HAR to R/$
2.5
14
12
2.0
10
1.5
8
1.0
6
0.5
4
0.0
2
95
96
97
98
99
00
Ratio HAR t o NMT
01
02
03
R/$
A lagged exchange rate effect is apparent in Figure 9: the price of Harmony (relative to
Newmont) is positively linked to the rand/US$ exchange rate, but a weaker exchange rate
translates into a stronger share price only after a lag of around nine months. Shareholders in
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Harmony do not appear to re-rate the share immediately, on the basis of a contemporaneous
exchange rate effect, but appear to wait for an extended period of rand weakness before they rerate Harmony .in relation to, for instance, Newmont. A similar effect was observed during the
gold price‟s sharp upward adjustment in January 1980: the higher gold price was not immediately
imputed into gold share values; the share market seemed to require a longer period of sustained
higher gold prices before it re-rate gold shares. The present study lends further support to these
conclusions, and indicates that gold shares are influenced a great deal more by a moving average
of past gold prices than the contemporaneous price.
In fact, a contemporaneous scatter plot of Harmony (with market- and sector-wide effects
removed) against percentage changes in the R/US$ yields a weak negative relationship (r = 0.204 from January 1995 to June 2003, and r = -0.389 from January 2000 to June 2003). There is
certainly no evidence of the Richemont effect; South African investors do not appear to use
Harmony as an exchange rate hedge.
Figure 11.
Rati o HAR to NMT and %R/$
1995.01 2003.06
60
40
% R/$
20
0
-20
-40
0.0
0.5
1.0
1.5
2.0
2.5
Rati o HAR to NMT
The more recent period (January 2000 to June 2003) indicates that, as we correlate Harmony
(stripped of market and sector effects) with lagged exchange rate movements, the correlation
increases, reaching a peak positive correlation of r = 0.332 with a 10-month lag. Thus, investors
in Harmony are more concerned with movements in the R/US$ exchange rate over the past year
and a half or so than they are with contemporaneous exchange rate movements. In many cases,
the focus is on attempting to price a longer term exchange rate equilibrium value alone, knowing
that it is this that may be the major determinant of earnings; near-term gold production may well
have been sold forward at a price known to the market.
15
Figure 12.
Rati o Har to NMT and % R/$ (l agged 10)
2000.01 2003.06
% R/$ (lagged 10 months)
60
40
20
0
-20
0.5
1.0
1.5
2.0
2.5
Rati o HAR to NMT
Case Study 3 — Pure Rand Plays
In the case of pure rand plays, there are no obvious benefits for share prices from nominal or
real rand weakness. Clearly, with only rand revenues and rand costs a weakening exchange will
imply, ceteris paribus, that the foreign exchange value of the earnings or dividends generated by the
rand play will fall or rise in proportion to the exchange rate. However, a weaker rand is followed
by higher inflation in South Africa with associated higher rand revenues and higher rand costs as
the movement back to PPP gets under way. Thus, the short-term effect on dollar dividends
might be seen as only temporarily negative. However, exchange rate shocks in themselves imply
a more unstable exchange rate environment for the future and more perceived risk for the
foreign holder of rand play shares. It might be expected that the foreign currency value of a rand
play deteriorates in immediate response to rand weakness, while rand strength should bring
immediate improvement in the foreign currency value of a rand play.
The evidence strongly supports this contention. We calculate the ratio of the JSE Banks index
(expressed in Australian dollars) to the associated ASE Banks index between 1996 and 2002.
When changes in this ratio are associated with changes in the rand/AU$ exchange rate, we get a
large negative estimated correlation of -0.78 (see Figure 13). Clearly, rand weakness causes the
real or relative value of South African banks to decline. Furthermore, over the same period, there
is also a negative correlation between changes in the rand value of the JSE Banks index and
changes in the R/AU$ exchange rate of -0.45. In other words, despite the higher inflation
associated with rand weakness, a weak rand not only negatively affects the relative foreign
currency value of SA banks; it also impacts negatively on their current rand values. This is
because a significant proportion of the shares in the JSE Banks index are held by foreign
shareholders for whom rand weakness is immediately very bad news in the form of immediately
diminished earnings and dividends. The equilibrating tendency for exchange rates to move back
to PPP seems to provide no short-term consolation for these shareholders.
16
Figure 13.
Change in SA banks/Ausbanks Vs R/AUD
60
Change in R/AUD
40
20
0
-20
-40
-100
-50
0
50
Change (SAbanks/AUS banks) AUD values
Conclusions
The JSE lists a mixture of rand leverage stocks, rand hedge stocks and rand plays. However, for
a number of reasons, few listed companies represent pure examples of one or the other category.
For example, the large South African industrial conglomerates have a mix of local and foreign
assets, and the large South African banks have significant proportions of their assets invested
off-shore. Nonetheless, the classification is strongly supported by the empirical evidence and is,
furthermore, useful as a framework for analysing companies‟ exchange rate sensitivities. We have
also shown how the sharp changes in nominal and real rand exchange rates between 2001 and
2003 proved a mixed blessing for JSE shareholders. Over this turbulent period, the lagged
impact of exchange rate changes on rand leverage stocks, and the more immediate impact on
rand hedges and rand plays, have tended to offset one other in the market; the aggregate effect
of exchange rate changes on the JSE has been moderate. Short-term movements in the JSE will,
however, continue to be dominated by the direction taken by the rand, on account of the
preponderance of rand leverage stocks on the JSE.
The rand, however, will not always be as variable as it has been recently. When the currency
stabilises, real valuations on the JSE will continue to reflect the real performance of the
companies listed on it. But this reality will be more a function of real economic developments in
the markets for goods and services in which these companies operate than of changes in the
nominal and real exchange rate.
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